SEC’s flash in the pan

September 18, 2009

Securities regulators will often settle for the proverbial low-hanging fruit — prosecuting easy cases that don’t make a big difference in the way Wall Street operates. But it does give the appearance they’re doing something.

And so it is with the Securities and Exchange Commission’s proposal to stamp out flash trading, an unsavory practice that has permitted some high-frequency trading desks to get a millisecond sneak peak at market trade orders.

Banning flash trading certainly makes sense, because there’s no reason that trading firms with lightning-fast, computer-driven buy and sell programs should get an advantage over the rest of the market.

But the furor over flash trading has always been something of a sideshow because it affects a minuscule percentage of the tens of millions of high-frequency stock trades made each day.

There’s reason to worry that after cracking down on flash trading, the SEC will consider its work largely done. Mary Schapiro, the commission’s chairman, says regulators are taking a hard look at a wide range of “market structure issues,” including high-frequency trading. But Schapiro has offered few specifics and largely spoken in generalities on the subject.

Schapiro hasn’t said much publicly on the two main criticisms of high-frequency trading: its ability to add unnecessary volatility to the markets, and its potential to spark a market meltdown because so many computer programs employ the same algorithmic strategies.

And Schapiro’s silence on the matter could leave one wondering just how rigorous this SEC review is going to be, and whether the ban on flash trading is all that regulators plan to take on.

Recently, I tried to gauge just how serious the SEC was. I submitted a Freedom of Information Act request, seeking information about investor complaints filed this year alleging possible high-frequency trading abuses, and the agency’s responses to those letter writers.

But I was told my request was too broad and needed to be narrowed. So I limited my inquiry to investor complaints regarding two separate and unusual trading events involving shares of United Airlines and Dendreon.

In the case of Dendreon, shares plunged 69 percent in less then two minutes on April 28 on a vague rumor the Seattle-based drug company was going to report some bad news.

Last September, UAL’s suffered an equally eye-popping plunge, after a six-year-old headline about the airline filing for bankruptcy erroneously hit some news wires.

Both bizarre events were widely reported and some critics say high-frequency trading may have exacerbated the super-fast selloffs. But the SEC says it can’t provide any of the information I requested because it could “interfere with enforcement activities.”

Now it shouldn’t come as any surprise that regulators might be looking into these unusual trading events. And the SEC’s desire to protect the confidentiality of its “enforcement activities” is understandable. But it’s hard to tell just how active these inquiries are, or whether this is just some bureaucratic boilerplate denial.

The UAL incident, for instance, is more than a year old. And there’s no mention of the SEC looking into either of these trading events in the regulatory filings for Dendreon or UAL.

However, it would be nice to know whether the SEC has made a preliminary determination about the impact of high-frequency trading on both those stocks. Or, that the agency is even bothering to look into the issue.

Update: Here’s a good discussion at an SEC roundtable on some of the potential issues I’ve outlined with high frequency trading. It was intended as a discussion on short-selling, but HFT kept coming up. Take particular note of Georgetown University Professor Jim Angel’s discussion of Dendreon, starting on page 114 of the transcript.

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